SUMO - Sumo Logic Accelerates Plans To Achieve Breakeven

Summary

• Sumo Logic, Inc. reported its FQ3 2023 financial results on December 5, 2022.
• The firm provides IT monitoring technologies to organizations worldwide.
• While Sumo Logic continues to grow revenue, operating losses are large.
• Apparently, private equity has become interested in a potential buyout, if rumors are to be believed.
• However, until management can make meaningful progress toward operating breakeven, I'm Neutral on Sumo Logic, Inc.

A Quick Take On Sumo Logic

Sumo Logic, Inc. ( SUMO ) reported its FQ3 2023 financial results on December 5, 2022, beating revenue and EPS estimates.

The firm has created a platform that automates the collection and analysis of enterprise IT infrastructure activity.

While management says it is seeking to achieve cash flow breakeven and become profitable, it has a long way to go before it reaches its stated goals.

I’m on Hold for Sumo Logic until we see evidence of a meaningful move toward cash flow breakeven and operating profitability.

Sumo Logic Overview

Redwood City, California-based Sumo was founded to develop log management software to enable organizations to continuously monitor and respond to their IT infrastructure in real time.

Management is headed by president and Chief Executive Officer Mr. Ramin Sayar, who has been with the firm since December 2014 and was previously SVP and GM at VMware, a virtualization technology company.

SUMO has created a three-part partner approach, with technology partners, system integrators & resellers and managed service providers extending the company's offering reach.

The firm provides a cloud-native platform with operational, security and business intelligence capabilities, referred to as its 'Continuous Intelligence Platform,' and refers to it as DevSecOps.

Customer Acquisition

SUMO provides its services to organizations of all sizes, from large enterprises to small and middle-market businesses.

The firm offers multi-tiered subscription packages for access to its platform, with pricing based on a number of factors.

Sumo pursues a 'land and expand' approach to its selling process, using a free trial to entice organizations to check the system out with no obligation.

The company has an inside sales team focused on middle-market prospects and a field sales group dedicated to larger enterprises.

Small-sized prospects are encouraged to use the self-serve system to trial and convert to paying customers.

Market & Competition

According to a 2020 market research report by ResearchAndMarkets, the global log management software market is expected to grow from $1.9 billion in 2020 to $3.7 billion in 2025.

This represents a forecast CAGR of 14.1% during the period.

The main drivers for this expected growth are a growing reliance on IT infrastructure, application sprawl and complexity and the increasingly large amount of data generated by businesses.

Cloud-based offerings are expected to grow at a much higher rate of growth.

By region, North America is expected to drive technological adoption due to a desire for faster troubleshooting, security improvement and government regulatory requirements.

Also, SUMO management believes the market for monitoring and response is far larger, in the tens of billions of dollars per year.

Major competitive or other industry participants include:

• Splunk ( SPLK )

• Elastic ( ESTC )

• Datadog ( DDOG )

• Amazon - AWS (AMZN)

• Microsoft Azure (MSFT)

• Google Cloud (GOOG)

• Numerous other smaller app-specific providers

SUMO’s Recent Financial Performance

• Total revenue by quarter has risen per the following trajectory:

• Gross profit margin by quarter has trended lower in recent quarters:

• Selling, G&A expenses as a percentage of total revenue by quarter have also trended lower recently:

• Operating income by quarter has deteriorated significantly:

• Earnings per share (Diluted) have remained heavily negative, as the chart shows below:

(All data in the above charts is GAAP.)

In the past 12 months, SUMO’s stock price has fallen only 1.5% vs. that of Datadog’s drop of 49.4%, as the chart below indicates:

Valuation And Other Metrics For Sumo Logic

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha)

As a reference, a relevant partial public comparable would be Datadog; shown below is a comparison of their primary valuation metrics:

(Source - Seeking Alpha)

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

SUMO’s most recent GAAP Rule of 40 calculation was negative (16.7%) as of FQ3 2023, so the firm has performed poorly in this regard, per the table below:

(Source - Seeking Alpha.)

Commentary On Sumo Logic

In its last earnings call ( Source - Seeking Alpha ), covering FQ3 2023’s results, management highlighted the firm’s improved sales productivity as well as headcount rationalization and cost savings initiatives as the key drivers of its revenue growth.

Leadership noted "less certainty and more noise in the macroeconomic environment’ while at the same time reaffirming its ‘plans to achieve cash flow breakeven and profitability."

However, management only spoke generally about such "plans" and didn’t provide any detailed timeframe for achieving such profitability.

As to its financial results, total revenue rose 27% year-over-year.

The company’s dollar-based net retention rate was 115%, indicating good product/market fit and solid sales & marketing efficiency.

However, management said that Q4’s net retention rate would be lower than in Q3 because of seasonality and some ‘known Q4 downsizing driven by budgetary pressures as some customers look to reduce spend in this uncertain macro environment.’

The firm’s Rule of 40 results have produced a reasonably strong revenue growth result more than offset by a very high GAAP EBITDA loss contributing to a negative figure for this metric.

While gross profit margin ticked up and SG&A as a percentage of revenue dropped, the firm posted heavily negative operating results and still substantial earnings loss.

For the balance sheet, the company ended the quarter with cash, equivalents and short-term investments of $322.1 million and no debt.

Over the trailing twelve months, free cash used was $33.5 million, of which capital expenditures accounted for $800,000. The company paid a hefty $65 million in stock-based compensation.

Looking ahead, management expects full-year 2022 revenue growth of around 23% year-over-year and a non-GAAP loss per share of negative $0.355 at the midpoint.

Note that non-GAAP results usually exclude the impact of stock-based compensation, which, in Sumo’s case, is a large impact.

Regarding valuation, the market is valuing SUMO at an EV/Sales multiple of around 3.8x, even after the recent stock price jump on unsubstantiated rumors of private equity firm interest in acquiring the company.

The Meritech Capital Index of publicly held SaaS software companies showed an average forward EV/Revenue multiple of around 5.2x on January 3, 2023, as the chart shows here:

So, by comparison, SUMO is currently valued by the market at a discount to the broader Meritech Capital Index, at least as of January 3, 2023.

The primary risk to the company’s outlook is an increasingly likely macroeconomic slowdown, which may produce slower sales cycles and reduce its revenue growth trajectory.

Notably, SUMO’s EV/Sales multiple [TTM] has compressed by 6.21% in the past twelve months, as the Seeking Alpha chart shows here, although the metric had been down by around 50% just before the recent price jump:

A potential upside catalyst to the stock could include a "short and shallow" macroeconomic slowdown.

However, while I do not know how the macroeconomic picture will play out in the near term, Sumo Logic, Inc. is still generating very high operating losses with only vague and nebulous references to accelerating plans to achieve profitability.

Until we see evidence that management is making serious progress toward profitability, I’m on Hold for Sumo Logic, Inc.

For further details see: